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I'm reading "A History of Money and Banking in the United States" by Murray Rothbard, and I'm having trouble understanding this one piece of history. Basically, the Massachusetts government issues irredeemable paper money in 1690 to help pay some debts to soldiers. In the next 40 years it further expanded its paper issue, causing rapid depreciation with respect to specie. To counteract this, the government passed legislation to make the paper legal tender at par with specie, and even granted a premium of 5 percent on all payments of debts from the notes. By Gresham's law, this led to loss of specie in circulation, and "In addition, the expanding paper issues drove up prices and hampered exports from the colony".

I have a couple questions to clarify.

  1. what exactly is the meaning of "granting a premium of 5 percent on all payment of debts"? My intuition tells me that this is simply that if you choose to pay your debt in paper, as opposed to specie, you will have to pay 5% less.

  2. How would expanding paper issues, which drive up domestic prices, lead to hampering exports in this context? The way I'm thinking of it, increased money supply would increase prices via inflation, but would also devalue the currency with respect to specie and foreign currencies. So if 1 unit of specie/ foreign currency is worth more of the paper notes, wouldn't it INCREASE exports, as things would be cheaper?

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  • $\begingroup$ Doesn't "make the paper legal tender at par with specie" mean that the government fixed the exchange rate between specie and paper? $\endgroup$ – Grada Gukovic Oct 22 at 20:24
  • $\begingroup$ Yes, I believe it means that it will enforce the original price that the notes were distributed at with respect to specie for payments of taxes and debts. For example, if originally 15 notes were equal to 1g of gold, and it has since depreciated to 25 notes equal to 1g of gold, they would force creditors to accept their debtors payments at the 15-1 ratio. However, I’m not 100% on this and was what I wanted to clarify in asking $\endgroup$ – Davis Owen Oct 22 at 21:26

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